Monday 14 March 2011 20.01 EDT
First published on Monday 14 March 2011 20.01 EDT

The mention of Bavaria may still conjure up images of rowdy beer halls, oompah bands and red-cheeked folk in dirndl and lederhosen, but the state capital, Munich, is revamping itself as Germany's answer to silicon valley.

The southern German state – the country's most prosperous together with its neighbour, Baden-Württemberg – has tried hard to shed its buttoned-up image. Historically an agricultural region that lacked natural resources, its transformation into a more hi-tech economy began after the second world war.

That doesn't mean Bavarians have given up their traditions. Michael Hinterdobler, director of international relations at the state chancellery, says both Bavarias are thriving: "There has been a renaissance. Young people go out with their iPod but also have a dirndl at home. It's not a contradiction any more."

Post-war Bavaria benefited from being under American occupation, and companies such as Siemens relocated from Berlin to Munich.

The region around the state capital, which generates a third of Bavaria's total output, is home to heavyweights such as BMW and MAN, but also hundreds of smaller biotech, IT and environmental technology firms that have sprung up in the past couple of decades, as well as 550 US IT firms. Recent start-ups include Linguatec, which produces automatic translation software and dictionaries, and Greenrobot, which creates mobile apps such as Quick Search and GroovieMovie.TV.

It hasn't all been plain sailing. Having built up a reputation for electronics and advanced manufacturing in the postwar years, Munich found its competitive position under threat in the mid-1990s. It was hit by a double whammy of the 1993-94 recession, which knocked its export-oriented industries, and a drop in demand for defence and aerospace, one of the region's strengths, as the cold war came to an end.

The state of Bavaria came to the rescue, selling €2.9bn (£2.5bn) of shares in government-owned energy and infrastructure companies and pumping the bulk of it into initiatives to nurture hi-tech industries. Bayern Kapital, a subsidiary of LfA Förderbank Bayern, Bavaria's state bank, was established with €75m in state money to provide venture capital for start-ups, especially in the risky hi-tech sectors.

But a factor in the region's success is a close-knit network of 13 universities and a plethora of public research organisations such as the Fraunhofer and Max Planck institutes. Academics at the London School of Economics laud Munich as a model of "institutional thickness".

"Money was put into universities, technical colleges and institutes of applied science, there was always a network," said Zeil. "What attracts foreign investors is this network."

More than 55,000 people work in research and development in and around Munich. For over two decades, Munich has had Germany's highest share of technology patents by population.

Max Nathan, a research fellow at LSE Cities, who co-wrote a paper on Munich published last December, has found many parallels between Munich and California's Bay area. "Over the past 60 years, both have shifted from mainly rural communities to hi-tech hubs. Both offer a strong economy and an excellent quality of life – something that's helped keep people in the area," he wrote.

Some 220 miles east in Dresden, Silicon Saxony is following the Munich model. It is an industry association of nearly 300 companies in the microelectronic, semiconductor, photovoltaic and software sectors, clustered around Dresden.

Germany has led the way on investing in renewable energy and is the biggest market in the world for solar module installations. One of the main players, and one of the pioneers, is Solarwatt, based in Dresden, which has been operating for 18 years and now employs 480 people, with a turnover of €300m. More than a quarter of that comes from building solar power stations, the rest from domestic rooftop and small-scale commercial installations.

Detlef Neuhaus of Solarwatt said the feed-in tariff Germany introduced a decade ago, which pays solar energy producers for any excess power they produce, has been crucial to its success. "In Germany, electricity generation from solar modules has found widespread acceptance," he said.

Efforts to turn Germany's former industrial heartland along the Ruhr and Rhine rivers into a European base for biotechnology have met with mixed success, however. North Rhine-Westphalia, Germany's most populous state, is using state subsidies to foster a network of biotech firms to transform the Ruhr region, which had been Germany's coal mining and steel powerhouse since the early 19th century. But Boris Mannhardt, managing director of BIOCOM Project Management, which set up a biotechnology website for the federal ministry of education and research, said dragging the Ruhr into the digital age is a big ask: "The scientific basis is quite weak in the Ruhr region. It's not strong enough for a commercial biotechnology industry to emerge."